California adopts single-sales factor apportionment formula for financial institutions effective January 1, 2025.
California Senate Bill 132 (S.B. 132), a taxation trailer bill that was attached to the state’s Budget Act of 2025 (S.B. 101), was signed by Governor Newsom on June 27, 2025, and enacted a single-sales factor apportionment formula for banks and financial institutions effective for tax years beginning on or after January 1, 2025. Direct lending funds that perform loan origination activities outside of California and have been filing as financial institutions in the state may see their 2025 California apportionment and tax liability double as a result of this change.
Under prior law, financial institutions used a three-factor apportionment formula comprised of receipts, property (including loans), and payroll factors with equal weighting to apportion their net income to California. For the property factor, loans were sourced under Cal. Code Regs. section 25137-4.2(d) to the location with which the loans have a ‘preponderance of substantive contact.’ This term means either the regular place of the taxpayer’s business to which the loans are assigned or the location where the taxpayer performed the preponderance (greater than 50 percent) of the loan origination for each loan.
Under the new law, financial institutions are required to use a single-sales factor apportionment formula effective beginning for the 2025 tax year. The property and payroll factors are no longer used to compute the financial institution’s apportionment to California.
If we assume Direct Lending Fund (DLF) which: (i) qualifies as a financial institution under state law, (ii) has 12% of its receipts in California, (iii) has 0% of its loans in California because it has a regular place of business and performs more than 50% of the origination activities for each loan outside of the state, and (iv) does not employ any people (that is, does not have a payroll factor), DLF would have had 6% apportionment to California, which is the average of 12% sales and 0% property, under the prior law. In contrast, under the new law DLF will have 12% apportionment to California which equals its sales factor.
Another legislative change that was enacted by the passage of S.B. 132 was the extension of California’s elective pass-through entity tax (PTET) for tax years beginning on or after January 1, 2026, and before January 1, 2031, subject to the application of the federal SALT cap under Internal Revenue Code section 164(b)(6) in those years. In other words, if the federal SALT cap is repealed, the California elective PTET will become inoperative as of January 1st of the following year.
The proposal to repeal the California water’s edge election, which Assembly Member Alex Lee (D) floated in a June 5, 2025, statement to Tax Notes, and which would have required taxpayers with nexus in California to compute state tax on a worldwide basis, has not been passed into law as part of the state’s budget for the 2025-2026 fiscal year which started on July 1, 2025.
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